Yesterday, Standard and Poor's announced America's AAA rating of US Treasuries is at risk. That was the reason analysts gave for the large stock market loss yesterday. Curiously, despite the grim news, US Treasury's performed quite well yesterday. Intermediate-term and long term treasuries rose in price by roughly 0.22% yesterday. Yet another stock market head-scratcher.
Why the negative outlook
US spending currently falls under the "drunken sailor" category, increasing our debt at record rates. And the relentless bipartisan bickering raises the possibility of failing to increase our debt limits, possibly resulting in the failure to make interest payments on our debt. This is some very scary stuff, and the rating agencies don't want to be caught sleeping again, as they were a few years ago when they gave AAA ratings to sub-prime mortgage derivatives.
Why did Treasury prices increase?
Riskier bonds must pay higher yields. That's why GM bonds, for example, went down in price as the bonds became riskier and riskier until they finally went into default. Thus, the increase in risk of US Treasuries should have resulted in prices going down and yields going up. The opposite happened.
I have three plausible answers for what happened:
- The S&P outlook change was expected. US stock futures were down before this S&P announcement. Thus, the news was a non-event.
- Investors seek safety in volatile stock markets. After a really boring last few weeks, stocks fell through the so called 1,300 S&P support level. Investors usually panic and move toward safety. They bought US Treasuries causing prices to increase.
- I don't know. As much as I hate to admit it, the real answer might be that I just don't know. Perhaps some large institutions needed to move into US Treasuries for unrelated reasons, driving up their prices. Markets are more complex than we think.
I'm putting my money on reason number three. But that brings with it some lessons as well:
- The stock market is volatile and our memories are short. What happened in 2008 and 2009 could easily happen again. Make sure you have the stomach to handle volatility and don't expect the recent past is a good predictor of the future.
- Quit trying to explain why the market does what it does on any given day. It will only lead you to think you understand the market better than you do.
- Congress should quit playing politics with our sacred AAA bond rating. I hope in the not too distant future to see governing become more of a priority than making the other party look bad.
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